Clarity on Recovery from Present Economic Crisis

1. Monday, February 9, 2009
EDITORIAL COMMENTARY
The Culprit Is All of Us
By SCOTT S. POWELL
The government's meddling got us into this mess.
CONTRARY TO A VIEW POPULARIZED DURING THE 2008 presidential election season, the
current economic crisis was not the result of deregulation.
The Bush administration made many mistakes, but deregulation was not one of them.
Not only was there no major deregulation passed during the past eight years, but the Bush
administration and a Republican Congress approved the most sweeping financial-market regulation in
decades.
The bipartisan Sarbanes-Oxley Act was enacted in 2002 to prevent corporate fraud and restore
investor confidence after the collapse of Enron and WorldCom. It failed to prevent the accounting
fraud and influence-peddling scandals at Fannie Mae and Freddie Mac. And even after those scandals
were widely understood, regulators sent Fannie and Freddie back into the market to continue buying
subprime loans, lending and borrowing with implied taxpayer backing.
Across the government, the Bush administration supported new regulations that added almost 1,000
pages a year to the Federal Register, nearly a record. If this is insufficient regulation, it's hard to
imagine a scope that would be effective.
We are in this mess largely because critical thought and moral judgment have been subordinated to
the politicization of our economy, resulting in regulatory gaps and excessive controls of the wrong
kind.
Government regulations should be limited to those that increase and protect transparency and
competition, protect public and private property, promote individual responsibility and enforce equal
opportunity under the law. Even if the right laws and regulations could be found, they would prove
insufficient to protect freedom and prosperity.

2. The Foundation of Economics
In his farewell address, George Washington said that religion and morality are essential to sustain
democracy in America. He might well have added that virtue is just as indispensable to its economy.
When the captains of banking and finance and their congressional overseers fail in moral judgment,
the results are disastrous for everyone. As we are now witnessing in the real-estate, stock- and bond-
market dislocations, once trust is lost, markets freeze and long-standing relationships break down,
resulting in illiquidity, irrational pricing and severe losses.
Today's problems have their roots in programs and financial instruments that shifted the locus of
moral responsibility away from private individuals and institutions to wider circles that were
understood to end with a government guarantee. Heads of the top banks and financial institutions
could approve substandard home-mortgage underwriting -- prone to increased default -- because
those loans could be securitized by Wall Street and sold off to investors or to government-sponsored
enterprises (GSEs), with no likely recourse to the financial institution of origin.
Our present crisis began in the 1970s, during the Carter administration, with passage of the
Community Reinvestment Act to stem bank redlining and liberalize lending in order to extend home
ownership in lower-income communities. Then in the 1990s, the Department of Housing and Urban
Development took a fateful step by getting the GSEs to accept subprime mortgages. With Fannie and
Freddie easing credit requirements on loans they would purchase from lenders, banks could greatly
increase lending to borrowers unqualified for conventional loans. In the name of extending affordable
housing, this broadened the acceptability of risky loans throughout the financial system.
No Surprise
The risk lurking in the GSE portfolios was acknowledged in the Bush administration's first fiscal-year
budget, released in April 2001. It stated that Fannie and Freddie were quot;a potential problemquot; because
quot;financial trouble of a large GSE could cause strong repercussions in the financial markets, affecting
federally insured entities and economic activity.quot; Fed Chairman Alan Greenspan issued repeated
warnings that the GSEs quot;placed the total financial system of the future at substantial risk.quot; Such
warnings went unheeded even after accounting scandals rocked Fannie and Freddie.
The collapse and government seizure of Fannie and Freddie in September 2008 ended the experiment
in partial socialization of the U.S. housing sector. Before we try complete concentration of federal
financial power, we should understand that power and political corruption abrogated moral judgment
on every level.
The poor and middle class were encouraged to live beyond their means and buy houses they couldn't
afford; speculators were lured into excessive risk-taking; banks were rewarded for lowering their loan
standards; and Wall Street found new windfall profits from securitizing and reselling bad loans in bulk.
With the support of regulators, credit-rating agencies provided cover for the whole charade.

3. Spreading Failure
There is plenty of blame to go around on both sides of the political aisle. But the lesson should be
clear that socializing failed businesses -- whether in housing, health care or in Detroit -- is not a long-
term solution. Expanding government's intrusion into the private sector doesn't come without great
risk. The renewing and self-correcting nature of the private sector is largely lost in the public sector,
where accountability is impaired by obfuscation of responsibility, and where special interests benefit
even when the public good is ill-served.
George Washington also warned against excessive partisanship, which distracts public councils and
enfeebles public administration. Rather than blaming the party in power or the party formerly in
power, the nation should stop living in denial of the mistakes of both parties.
Spreading failure across the entire economy risks turning a recession into a depression. Regulatory
reform now must foster responsible behavior and financial accountability. Far better for our citizenry
and businesses to have a strength and resourcefulness that comes from creativity, honesty and self-
reliance than to have a growing dependence on a profligate government.
SCOTT S. POWELL is a senior VP at ELP Capital, which manages a commercial real-estate debt-based hedge
fund; a visiting fellow at the Hoover Institution; and a Commerce Bridge board member.
Editorial Page Editor THOMAS G. DONLAN receives e-mail at tg.donlan@barrons.com.
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